The PSC Lifecycle: Setup, Dormancy and Closure Around IR35

Most contractors think about their limited company twice: the week they form it and the month they shut it down. Everything in between runs on autopilot. That habit is expensive, because the decisions that determine how much tax a personal service company ultimately pays, and how well it stands up to an IR35 challenge, are spread across the whole life of the company. This guide follows a PSC from incorporation through trading, dormancy and closure, and flags the traps at each stage.

Setting up a PSC with status defence in mind

A company formed in twenty minutes with model articles, a single £1 share and the contractor’s home address will function, but it gives away easy ground. From the first day, the company is evidence in any future status argument, so it pays to incorporate like a business rather than a payroll wrapper.

Articles and share structure deserve a moment of thought. Model articles are usually fine, but the share structure should reflect who genuinely owns and works in the business, and any spousal shareholding should be ordinary shares with full rights, set up before the income arises rather than rearranged afterwards. A registered office at an accountant’s address or a proper office service, rather than a kitchen table, is a small professional signal. Business insurance carries real weight: professional indemnity and public liability cover are things employees never buy, so holding them from day one supports the in-business-on-own-account picture as well as protecting the company commercially.

Posture matters too. A company that markets itself, quotes for work from more than one client, owns its own equipment and carries its own training costs looks like a supplier. None of this decides status by itself, but when an engagement is later weighed against the tests described in the guide to working outside IR35, the company’s history either supports the contractor or quietly contradicts them.

Running the company well

Good housekeeping during the trading years is mostly discipline. Hold and minute board decisions, even as a sole director, and in particular minute the status review of each new engagement: what was assessed, what the working practices are expected to be, and why the company concluded the contract sits outside or inside. A contemporaneous minute is worth far more in an enquiry than a reconstruction years later, and it demonstrates the company took the question seriously at the time.

Profit extraction needs revisiting under the current rates. From 6 April 2026 dividends are taxed at 10.75% in the basic rate band, 35.75% in the higher rate band and 39.35% at the additional rate, with a £500 dividend allowance, replacing the old 8.75% and 33.75% rates that ended on 5 April 2026. The higher rate rise in particular changes the arithmetic on stripping profits out each year. Corporation tax remains 25%, with the 19% small profits rate and marginal relief between £50,000 and £250,000 of profits, so a company retaining profit rather than paying higher rate dividends defers a meaningful personal tax cost.

Retained profits are not just a deferral. A warchest inside the company smooths gaps between contracts, funds the company through an inside stint without forcing closure, and ultimately becomes the pot that capital treatment on closure applies to. The trade-off is that money left in the company is exposed to how the closure rules treat it later, which is exactly why the closure sections below matter long before anyone plans to close. One caution while extracting: an overdrawn director’s loan account left unpaid attracts a section 455 charge at 33.75% in 2026/27, a rate that notably did not rise alongside the dividend higher rate, and the charge is only repaid to the company when the loan is cleared.

Going dormant during an inside stint

An inside IR35 engagement does not require the company to die. Plenty of contractors take a year or two on umbrella payroll or under deemed payments and then return to outside work, and for them dormancy is usually cheaper and simpler than closing and reincorporating. What an inside stint involves day to day is covered in the guide to working inside IR35; this section is about what to do with the company in the meantime.

A company is dormant for Companies House purposes when it has no significant accounting transactions in the period. Dormant company accounts are short and cheap to prepare, and the annual confirmation statement still has to be filed, so the running cost of a parked company is modest. HMRC should be told the company has ceased trading so it stops expecting full corporation tax returns. Money already in the company can simply sit there; dormancy does not force a distribution.

• File dormant accounts and the confirmation statement on time, since late filing penalties apply to dormant companies too.
• Tell HMRC the company is no longer trading so corporation tax notices stop.
• Decide deliberately on VAT: deregistering saves nil returns but means re-registering later, while staying registered means filing nil returns every quarter.
• Keep the registered office, insurance run-off cover and statutory registers current so the company can restart cleanly.

VAT is the genuine trade-off in that list. Deregistration is tidy if the inside stint looks long, but a contractor who expects to be back outside within a year often keeps the registration and files nil returns, avoiding the friction of a fresh application and a new VAT number on every invoice template and contract. PAYE schemes can usually be left open with nil submissions for a while, or closed and reopened, and the right choice depends on how certain the return to contracting is.

Closing the company: strike-off or MVL

When contracting is genuinely over, the company has to be wound down, and the route depends almost entirely on how much is left inside it. The dividing line is £25,000. On a voluntary strike-off, distributions to shareholders are treated as capital only if the total does not exceed £25,000; if distributions go over that figure, the whole amount is taxed as dividend income, not just the excess. With reserves below the line, strike-off is the cheap route: settle all liabilities, distribute the remainder, file the DS01 and let the company dissolve.

Above £25,000, a Members’ Voluntary Liquidation is the standard answer. An MVL is a formal solvent liquidation run by a licensed insolvency practitioner, and distributions made in a winding up are capital by default, with no £25,000 cap. The practitioner’s fee means an MVL only makes sense where the tax saved comfortably exceeds the cost, but for a company holding six figures of retained profit the difference between capital gains treatment and dividend rates at 35.75% or 39.35% is usually decisive. A specialist can run the strike-off versus MVL comparison on actual numbers, including timing distributions across tax years and using both spouses’ annual exempt amounts where shares are jointly held.

Business Asset Disposal Relief from April 2026

Capital treatment gets better still where Business Asset Disposal Relief applies, though the relief is less generous than it once was. Disposals from 6 April 2026 are taxed at 18% under BADR, up from the 14% rate that applied to 2025/26 disposals. The lifetime limit is £1 million of qualifying gains, which is far more headroom than a typical PSC closure needs.

The conditions are personal and time-based. Throughout the two years ending with the disposal, the individual must have been an officer or employee of the company, the company must have been a trading company, and the individual must have held at least 5% of the ordinary shares and votes, with an equivalent economic entitlement. For a contractor who has owned and directed their own PSC for years, the conditions are normally straightforward, but two situations need care. A long dormancy before liquidation can put the trading company condition under pressure, since relief on a winding up generally requires the company to have been trading within a set period before cessation, so a company parked for years and then liquidated may have left it too late. And resigning the directorship before the closure process completes can break the officer condition at exactly the wrong moment. Neither trap is hard to avoid with sequencing, which is one more reason to plan closure rather than drift into it.

The TAAR and the two-year trap

The targeted anti-avoidance rule in section 396B ITTOIA 2005 is the rule that catches contractors who liquidate well and then go straight back to the same work. Where a shareholder receives a distribution in a winding up and, within two years, carries on the same or a similar trade or activity, and obtaining a tax advantage was a main purpose of the arrangements, the distribution is retaxed as income. At 2026/27 dividend rates that converts an 18% capital receipt into income taxed at up to 39.35%, unwinding the entire benefit of the MVL.

The classic trap is the new PSC. A contractor liquidates the old company, banks the capital-treated distribution, and within two years incorporates a fresh company to take a new contract doing the same kind of work. That is precisely the phoenix pattern the TAAR was written for. The two-year clock and the same-trade test are mechanical, but the main purpose test is not, so outcomes depend on the facts: a contractor who closed down intending to retire or take permanent employment, and was later pulled back to contracting by a genuine change of circumstances, stands differently from one who planned the round trip. Continuing the same trade as a sole trader or through a partnership can also trigger the rule, since the test looks at the trade, not the vehicle. Anyone contemplating contracting again within two years of an MVL should take advice before signing anything, because the cleanest protection is simply waiting out the period or not claiming capital treatment in the first place.

Moving to permanent employment

Leaving contracting for a staff role is the tidiest exit, and it strengthens the closure position, since a genuine move to employment makes the TAAR’s main purpose test much easier to satisfy. The unwinding still needs doing in the right order. VAT deregistration should be applied for once taxable supplies have ceased, with a final return accounting for any assets on hand above the de minimis level. The PAYE scheme closes with final submissions marking the scheme as ceased, and any outstanding salary, expenses and pension contributions should go through before that point. Final accounts and a final corporation tax return draw a line under the trade, and only then should distribution and dissolution or liquidation follow.

Timing the last extraction around the employment start date is worth modelling. A contractor starting a well-paid permanent role mid-year may already be in the higher rate band, so a closing dividend that might have been cheap in a quiet year suddenly costs 35.75%. Pushing the distribution into the capital regime through an MVL, or simply timing it before the salary starts, can change the outcome materially. This is a one-shot decision, and a specialist accountant can model the closure routes against the new salary before anything irrevocable is filed.

Treating the lifecycle as one plan

The thread running through every stage is that PSC decisions compound. The insurance bought at setup becomes status evidence five years later. The profits retained at 25% corporation tax become the pot that strike-off, MVL, BADR and the TAAR fight over at the end. The dormancy choice during an inside year decides whether there is a company left to restart when an outside contract appears. Contractors who hold the whole arc in view pay less tax and defend status better than those who treat each year in isolation, and an accountant who works with contractor companies every week will see the arc faster than a generalist.